China’s State Administration of Foreign Exchange (SAFE) last year used its funds to convince Costa Rica to cut ties with Taiwan and establish a firm relationship with Beijing, The Financial Times reported last week, citing documents obtained by the news agency. The development underscores Beijing’s ability, and willingness, to use China’s growing financial might to advance its political agenda.

On June 1, 2007, the two parties signed an agreement authorizing China to purchase $300 million in Costa Rican government bonds, so long as the Central American nation cut ties with Taiwan, after 63 years, and forge a new relationship with Beijing, the FT reported.

That document, which stipulated that Costa Rica take the “necessary measures to prevent the disclosure of the financial terms of this operation and of SAFE as a purchaser of these bonds to the public,” was signed into effect by Yang Jiechi, China’s foreign minister, and Bruno Stagno Ugarte, foreign minister of Costa Rica.

Later, in January of this year it was carried out, in part, by SAFE, which bought $150 million in U.S. dollar-denominated bonds from the Costa Rican government. SAFE will purchase the remaining $150 million in January 2009. China is to give Costa Rica another $130 million in direct economic aid that will not be repaid, in addition to bond purchase.

“This is the first smoking gun that proves China uses its foreign exchange reserves for political purposes,” Kerry Brown, senior fellow with the Asia program at Chatham House in London, told the FT. “It raises questions about some of SAFE’s other investments and will worry politicians and business people in places where SAFE is taking stakes in high-profile companies.”

Many of the countries that maintain diplomatic ties with Taiwan are poor developing nations to which it provides aid and infrastructure investment. China, which still considers Taiwan part of its territory, would very much like to convince those countries that Beijing could be a better friend than Taipei, and now it has the checkbook to back it up.

China leads the world with a cache of about $1.81 trillion in foreign currency reserves, and the vast majority of those reserves are reportedly controlled by SAFE – Beijing’s highly secretive sovereign wealth fund that often operates through subsidiaries it refuses to acknowledge even exist.